Marlboro maker places $1.8 billion bet on marijuana

UPDATED: Fri., Dec. 7, 2018, 6:11 p.m.

Store manager Stephanie Hunt poses for photos July 17, 2015, with a pack of Marlboro cigarettes, an Altria brand, at a Smoker Friendly shop in Pittsburgh. Altria is diving into the Canadian cannabis market with a $2.4 billion investment in Toronto-based medical and recreational marijuana provider Cronos Group. The investment from Altria Group Inc., would give it about 45 percent ownership of Cronos. Altria will also pay another $1.4 billion for warrants of Cronos Group that if exercised, would give the Altria a 55 percent majority ownership of Cronos. (Gene J. Puskar / AP)

Altria Group Inc., the U.S. maker of Marlboros, made a $1.8 billion investment in a Canadian pot company Friday based on a simple premise: Cannabis is growing fast, and cigarettes are not.

Altria has agreed to take a 45 percent stake in Toronto-based marijuana producer Cronos Group Inc., marking a major tobacco company’s first foray into cannabis. It has the option to take majority control in the future. The tobacco giant simultaneously said it will kill two of its next-generation products, fueling talk that a potential deal with Juul Labs Inc. could come soon.

With U.S. smoking rates falling fast, Richmond, Virginia-based Altria is under pressure to find new avenues to expand. Marijuana is now allowed in an increasing number of states but is still illegal on the federal level in the U.S. That makes Canada, which legalized recreational use in October, a large laboratory for the nascent industry.

“We believe cannabis is an excellent strategic fit for tobacco,” Jefferies analyst Owen Bennett said in a research note earlier this week. It’s a logical fit, because “big tobacco knows how to cultivate crop, knows how to deal with regulators, they are at the forefront of vaporization technology, and they also arguably have less reputational risk than other fast-moving consumer goods,” he said.

It’s clear Altria has reassessed its competitive position. It also announced Friday that it will discontinue two of its next-generation tobacco products and its oral nicotine-containing ones to focus on “more compelling reduced-risk tobacco product opportunities.” The company attributed this to regulatory restrictions and lack of financial prospects for those products.

This suggests “an announcement to acquire a stake in Juul could come very soon,” Wells Fargo analyst Bonnie Herzog said in a Friday research note. Juul could compliment the cannabis business, she said.

Altria shares rose as much as 3.2 percent to $56.14 on Friday. Its stock had fallen 24 percent this year through Thursday’s close — illustrating how investors had become pessimistic about the company’s future amid rising regulations and taxes on tobacco.

The company isn’t likely to rush into exercising the warrants that could bump its stake up to 55 percent, but it’s possible that Cronos will eventually become part of the tobacco giant, said Bloomberg Intelligence analyst Kenneth Shea.

“It looks like an understanding that they would become one and the same,” Shea said, noting that Altria will also have four of seven board seats.

Altria got a good deal, particularly as Cronos is one of a dwindling number of licensed cannabis producers that haven’t already established an exclusive relationship with a consumer products company, he said.

Cowen analyst Vivien Azer said it’s not surprising that Altria opted for a pathway to a majority control of Cronos. Altria is paying 25 times forward sales, she said, and in her view, Altria is “buying their way out of a bind” after almost two decades of volume decline for U.S. cigarettes, and a challenging 2018 for e-cigarettes.

Cronos CEO Mike Gorenstein said the partnership with Altria doesn’t limit the cannabis firm from engaging with other strategic partners.

“In fact, we think this partnership makes us collectively a more attractive partner” for other potential investors, Gorenstein said on a conference call Friday. The most attractive piece of the partnership is Altria’s experience dealing with regulatory agencies, he said.

Altria has been grappling with a Food and Drug Administration that’s intent on strengthening restrictions on some of the vaping products that have caught on with younger users.

Philip Morris International Inc., declined to comment on the deal, but said it doesn’t change anything with respect to its plan to use products like its smoke-free IQOS device to replace cigarettes.

Philip Morris, which was spun off from Altria and sells the Marlboro brand internationally, has been trying to get approval for Altria to market IQOS in the U.S. Separately, it has asked for regulatory permission to say the device carries a lower health risk than regular tobacco products.

Cronos’s Gorenstein said his company and Altria agree that developing brands and intellectual property is more valuable than growing plants and should be the focus going forward.

“When we were strategically planning how we would enter cannabis years ago, one of the companies that we looked at and had a lot of respect and admiration for was Altria,” he said. “It’s worth noting that Altria does not grow their own tobacco. We think that model of growing your own plants is very difficult to scale and to execute well. That was something we’re very aligned with.”